Lifetime Allowance And Benefit Crystallisation

The Lifetime Allowance And Benefit Crystallisation

The amount of benefits that could be built in a pre-'A' Day occupational pension scheme was limited by HMRC rules, whereas benefits under an individual pension scheme was unlimited; it depended on what the value of the benefit was at the time of retirement. These differences have be cast aside since 6th April, 2006 and substituted with a 'lifetime allowance' that limits the amount of benefits that can be amassed in a tax-advantaged environment.

The lifetime allowance for 2007/2008 was 1.6 million; 2008/2009 is 1.65 million; 2009/2010 will be 1.75 million and 1.8 million will be the figure for 2010/2011 tax year. The figure will be reviewed every five years and confirmed yearly by the Treasury. Note that the figure for a particular year cannot be less than that of a previous year.

Anytime a pension benefit is drawn a proportion of the lifetime allowance is consumed. It is necessary to
test any benefit withdrawn with the lifetime allowance to see if the limit has not been breached. Any amount received in excess of the limit will attract a tax charge, and the amount of charge will depend on whether pension income or cash lump sum is being taken. A tax charge of 25% will have to be paid on excess pension income whereas 55% tax charge will have to be paid on a lump sum excess.

For a given tax year, certain individuals can have lifetime allowances higher than the standards mentioned above. This may be the case if the individual is a non-resident of the UK or if there has been a pension credit from a pension share order issued in a divorce case, before 'A' Day. A higher lifetime allowance can also be the privilege of a person who built up benefits prior to 'A' Day and possesses transitional protection.

Essentially pension income can be taken in the form of scheme pension when considering a final salary scheme; a lifetime annuity, which is annuity purchased
with a money purchase fund, is another possibility. Members with ages below 75 can employ unsecured pension, which has to do with drawing income directly from the funds of a money purchase scheme. Alternative secure pension is the approach used to draw income directly from a pension fund by those over age 75.

Whenever a benefit is drawn whether in the form of income or a cash lump sum, a 'benefit crystallisation event' is said to have taken place. As mentioned above, it will be necessary then to test the benefit received with the lifetime allowance, in order to assess the tax charges on any potential excess. Note that it is not the benefit per se which is tested against the lifetime allowance but the 'value' of the benefit.

There were originally eight kinds of benefit crystallisation events (BCEs), but HMRC has added a nineth. BCE1 has to do with benefits drawn as unsecured pension under a money purchase scheme and is valued as the market value of the fund. Pension income drawn as scheme pension is denoted by BCE2 and is valued by multiplying the amount of the benefit by a factor of 20. Should the amount of the scheme pension be greater than the maximum that was agreed by law at the start of the pension, the increase is represented by BCE3 and also valued by multiplying the amount by a factor of 20. BCE4 stands for lifetime annuity purchased with a money purchase fund, and is valued as the amount of the fund used in buying the annuity. At age 75 uncrystallised scheme pension and lump sum received is denoted by BCE5 and valued by multiplying the pension by a factor of 20 and adding the amount of the lump sum to the multiple. BCE5A indicates the drawing of unsecured pension at age 75. It is valued by finding the difference in market value between the unsecured pension at age 75 and the amount designated to the unsecured pension at the outset. Lump sum received at retirement is indicated by BCE6 and valued as the amount of lump sum taken. BCE7 denotes lump sum at death from either a scheme pension or the uncrystallised funds in a money purchase scheme. When pension benefits are transferred to a recognised and qualified pension scheme overseas, it is represented by BCE8, and valued as the amount of the fund transferred.

As much as one would want to enjoy the tax advantages of the new pension regime, it is advisable to keep an eye on the lifetime allowance when building and drawing benefits from any pension scheme. This will be a step in the right direction to eschew any unnecessary tax charges. After all what would be the gain if you utilise the tax privilege only to lose it through a tax charge inadvertently?

I have a BA Hons. degree in Accounting and Finance. I am currently specialising in Financial planning.

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